IncomeDemographicsESTONIAHUNGARYLATVIAPOLANDROMANIASLOVAK REPUBLICSLOVENIAFinancial liberalization, Saving, and Growth: the Experience of Transition Economies in Eastern Europe Corina Gavrea ECON 699 Proposal Advisor: Dr. M. Bradley April 15, 2004I. Introduction In the recent years it has become a common idea that a high level of saving and investment is one key element of sustained economic growth. The difficult access to international capital markets in Eastern Europe makes domestic saving the most important source of investment for these countries. Before the beginning of the transition process, Eastern European countries had very high saving rates. This situation started to change once the transition process began and saving rates dropped sharply from levels around thirty percent of GDP to about ten percent in early transition years. Even though some Eastern European countries like Poland, Czech Republic and Hungary registered an increase in economic growth, most of them were not capable of matching these three leaders and experienced falling or stagnant economic activity in the past decade. One possible reason for this stagnation could be a low level of saving and investment. Most of the empirical literature on saving focuses on industrialized countries, neglecting the analysis of transition economies (one explanation could be the poor quality of economic data for these countries especially for Eastern Europe). The objective of this paper is to analyze the developments of domestic and private saving in the future EU member states in the Baltics and Central Eastern Europe. The countries under consideration are: Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovak Republic and Slovenia from Central and Eastern Europe and Estonia, Latvia and Lithuania from Baltics. Besides focusing on determinants of private and public saving, this paper will also attempt to answer other open questions. Is there a correlation between 2saving and financial liberalization? Do the demographic variables have any impact on the saving rate? II. Trends in saving rates The last decade was characterized by a severe decline in saving rates, from levels around thirty percent of GDP (before transition) to low twenties and even tens, in almost all transition economies of Eastern Europe. One explanation for the high saving rate during the socialist era could be the “involuntary” or “forced” saving, caused by the lack of consumer goods. The possibility of involuntary savings during socialist era was the subject of many debates. Involuntary savings can exist if consumers don’t have access to any goods or asset market where price movements can equate demand and supply1. However, the results obtained by Denizer and Wolf (2000) 2 offers some evidence for the presence of involuntary saving in almost all EU accession countries (except for Czech Republic). The gross domestic saving rates are reported in Table 1. Pre-transition savings rates were among the highest in the world, with the highest level of saving rate in 1989 registered in Poland (42.7 percent of GDP). With the beginning of transition process3 saving rates dropped sharply from levels above thirty percent to less than twenty percent. This collapse in savings might be explained by the elimination of the involuntary savings. Other reasons for the reduction in saving rates could be: high inflation, high unemployment rate and a reduction in GDP. 1 Dornbush and Wolf (2000); “Monetary overhangs” 2 Denizer and Wolf (2000); “The Savings Collapse during Transition in Easter Europe”. The paper is part of a World Bank research project entitled “Saving Across the World” 3 Transition began in 1990 in Czech Republic, Hungary, Poland, Slovenia, Slovak Republic; 1991 in Romania and Bulgaria and in 1992 Baltic countries (Latvia, Lithuania, Estonia). 3Once the economy begun its recovery, in many EU accession countries, saving rates registered a slight increase and remained relatively stable during the recent years. Table 1: Gross domestic saving rates as a percentage of GDP 4 Country 1989 1990 1991 1992 1993 1994 1995 Bulgaria 31.3 22 26.8 14.1 7.6 8.7 14.1 Czech Republic 30.6 27.8 30.1 27.5 28.4 27.1 29.3 Estonia 25.9 22.3 34.5 32.7 22.4 16.5 18.6 Hungary 29.9 28 19.5 15.8 11.8 15.7 22.7 Latvia 34.7 38.8 43.5 48.1 25 20.8 15.2 Lithuania 25.8 25.2 32.9 19.2 11.4 12.4 12.6 Poland 42.7 32.8 18 16.7 16.5 19.9 22.1 Romania 29.5 20.8 24.1 23 24 22.7 18.7 Slovak Republic 28.5 24.2 28.2 24.1 21 26 28.2 Slovenia 33 32.6 26.4 24.7 20.4 23.2 21.13 Average 31.2 27.45 28.41 24.59 18.85 19.3 20.263 Standard Deviation 4.91 5.77 7.45 10.04 6.76 5.92 5.6 Country 1996 1997 1998 1999 2000 2001 2002 Bulgaria 13.5 14.45 17.11 12.1 12.9 12.8 12.1 Czech Republic 28.6 26.6 28.8 26.8 26.3 27 NA Estonia 16.3 19.4 18.9 19.6 23.7 24 23.3 Hungary 26.1 27.7 27.6 26 27.2 25 NA Latvia 10.8 14.3 14.1 16.7 18.5 18.8 19.5 Lithuania 14.7 15.9 12.4 12.4 14.3 16.3 16.5 Poland 20.3 20.2 21 20 18.4 17.1 15.7 Romania 17.4 13.6 9.72 11.2 14 13.8 14.6 Slovak Republic 24.4 25.7 24.1 23.9 24 23.4 22.9 Slovenia 22.5 23.4 24 24 24.2 25.1 NA Average 19.56 20.39 19.27 19.35 20.28 21.1 18.75 Standard Deviation 5.75 5.21 6.87 5.82 5.49 4.7 3.74 4 Data source – World Bank Development Indicators, own calculations. 4III. Theoretical determinants of saving and previous findings Because understanding the determinants of saving is crucial in designing a number of policy interventions, the analysis of saving behavior has become one of the most important issues in empirical macroeconomics. Many of the empirical studies have used aggregate saving figures while only a few focused on private saving. However, because private saving is the main component of domestic saving, discovering the determinants of private saving is of great importance for economists and policy makers. The determinants of savings most often used in empirical studies are discussed below. Income The existing literature not only suggests that income is positively correlated to saving, but also that income plays a key role in explaining saving behavior5 (Loayza, 1999). High income will improve per capita income of households; this will induce them to save more. Thus, richer people can afford to save for their future consumption, but the poor people have low incomes that only allow them to consume at the minimum level. Growth Modigliani showed many years